Alberto Camoes shared insights with Global M&A Network about the underlying principles fueling growth in the Brazilian economy, incentives in the legislation that has spurred overseas private equity investments, the hurdles faced by foreign investors in sourcing deals and conducting due diligence, complexity of the tax structure posing sizeable risks, along with Stratus' success in originating mid-market deals and emphasizing good governance of portfolio companies.

Q.: Brazil fared relatively well during the financial and economic downturn of 2008-2009. In your opinion, what are the fundamental reasons for this and the continuing growth of the Brazilian economy?

Mr. Camoes: Fortunately, there has been a number of elements that contributed to that: a Brazilian economy with relatively low dependency from international trade, the relatively low leverage of the Brazilian corporate sector and individuals (that's the positive side of high interest rates...), and the strength of the financial system.

Moreover, around 36 million Brazilians entered the middle class during the last 6 years or so, creating a boom of consumption that helped to counter-balance the effects of the crisis.

Q.: How is Brazil uniquely different in comparison to other BRIC's--India, China and the Russian markets?

Mr. Camoes: Although many people perceive Brazil as a commodity driven economy, the fact is that two thirds of the Brazilian economy is service driven. Internet usage is also the higher among the BRIC countries. Brazil also has a much lower trade as percentage of GDP - only around 23%, compared to 46-49% in the other three BRIC countries, so in some ways we are closer to the US than to an emerging country dependent on the exporting of manufactured goods or commodities.

Q.: As was the case with China, do you anticipate increase in investment opportunities as a result of the Olympic Games and World Cup? What are the risks?

Mr. Camoes: Yes, we do anticipate an increase in investments due to these sport events, with construction and infrastructure naturally being the most impacted sectors. One has to be careful, however, not to enter such sectors in "peak earnings" time, with high transaction valuations, so investing in these areas is not something we are seeing necessarily as great PE opportunity, differently from companies in these sectors.

Q.: What are the unique characteristics of investing in the Brazilian infrastructure? Beyond infrastructure, what related sectors are a "great PE opportunity" as result of the games?

Mr. Camoes: The relatively high interest rates in Brazil, and the fact infrastructure debt has to be denominated in Brazilian reais, make the debt part of any infrastructure project challenging. BNDES earmarked loans (that fortunately has been in place often) are the usual solution for this issue. In addition to that, many peripheral sectors (construction, engineering, materials, services, etc) represent opportunity for non infrastructure PE investments.

Mr. Camoes: Besides the growth factor, Brazil has passed legislation to give incentives to foreign investment in PE - no capital gains tax to foreign non-tax haven investors. It's probably one of the easiest BRIC markets to make investments and repatriate capital, without any type of capital control. Additionally, the government influence is only on a few sectors.

Q.: What are the hurdles and risks to overseas private equity investors?

Mr. Camoes: Foreign investors have to pass the sourcing and relationship, hurdle, mainly in the middle-market, where we are active. Political conditions are also very good - a recent LAVCA (Latin American PE Association) survey gave Brazil and Chile the highest rankings in Latin America in a score to measure the PE environment friendliness, with a score similar to Spain.

Q.: Could you elaborate on the sourcing and relationship hurdle faced by foreign PE funds and potential solutions?

Mr. Camoes: Foreign PE funds normally source deals through advisors, or in sectors in which they have an edge. Partnering up with local PE firms is sometimes a way to add local proprietary origination and join forces in a transaction.

Q.: How is the rising competition by private equity firms in Brazil impacting valuations? With more players in the market, have the PE deal structures changing?

Mr. Camoes: The impact in valuations has been felt more in the USD 100 million or higher equity check transactions, as there is more competition and less targets in this segment. In the middle market, with 15,000 or so companies, and not many players, valuations are still reasonable, even more considering the double digit growth of many sectors and companies. Deal structures have not changed significantly - with a 12% interbank interest rate in Brazil, leveraged transactions are still not the norm, and should become more common when interests fall.

Q.: How does Stratus differentiate itself from other mid-market firms local or foreign? Has your investment strategy changed in light of increased competition?

Mr. Camoes: We aim to differentiate ourselves, among other factors, through proprietary transactions, and by mixing pro-active deal sourcing with opportunistic deal origination coming from the 100+ brokers and finders network we developed since our foundation in 1999. For instance, we've screened 250 sub-sectors of the economy with 10,000 companies with combined revenues of R$ 1 trillion, and selected 27 sub-sectors to focus given sector dynamics like critical mass, rate of growth, and fragmentation. This type of screening serves as a basis for our pro-active deal sourcing.

Q.: What sectors are most attractive for Stratus Investments over next 12 months, and why?

Mr. Camoes: In general sectors catering to the booming middle class in Brazil, or which are very fragmented and would benefit from a consolidation. Examples are specialized retail, logistics, business services, among others. We tend to avoid sectors that are dependent on exports or international trade, as our investment play is more domestic.

Q.: In your experience, how is the due diligence process different in Brazil?

Mr. Camoes: The vast majority of companies in Brazil are not audited, so due diligence is paramount. Brazil has one of the most, if not the most complex tax structure in the world, and knowing how to deal with tax contingent liabilities during due diligence, and structure around it, are very important in Brazil.

Q.: To achieve sound due diligence, what are top 3 steps you recommend? How does Stratus conduct due diligence - that is what you most closely look at?

Mr. Camoes: Select not only a big four firm, but the best partners and professionals there - unfortunately, in a hot market, quality suffers. Understand the risks around contingent liabilities, and know how to structure around it - contingent liabilities are often sizable in Brazil. And last but not least, do a reference check not only through a professional firm, but also through people you know well that know well the potential target and its shareholders - then you know you'll be getting the true and whole story

Q.: How do you source deals given your local roots? What are the prospects and risks of investing in family owned business--which dominates the Latin American regions?

Mr. Camoes: We source deals either through the personal network of the firm partners, or through pro-active deal sourcing in sectors we consider priority target. As a result, around 80% of our transactions are truly proprietary. Another misconception is that you have to invest in "family owned" companies in the sense there are many family members or generations to deal with. In fact, even if statistics show 80-90% middle market companies to be family owned, most of them are still founder owned, with many of them without a second generation working there or willing to follow their family or parents steps.

Currently, family companies in Brazil are culturally closer to their US counterparts than to other Latin American countries, as they have seen many successful examples of partnerships with PEs that added value to their companies and are more willing to relinquish control as a means to make the company grow - and increase the value of their shares.

Q.: As an investor, how do you drive growth in your portfolio companies?

Mr. Camoes: We put a lot of stress in corporate governance, not only at the board level, but also at the officers' level. Many times we have to provide corporate governance training, as most of companies are family or founder owned, and the owner managers or executives do not have necessary governance experience. Also, sometimes they are executives from multinationals, with distance from the parent's board and limited corporate governance issues at a Brazilian subsidiary level. We also add value through acquisitions, as this is part of our strategy to grow most companies we invest in.

Q.: Please provide with at least two key issues around corporate governance that you most focus on?

Mr. Camoes: Really separating the board from the executive positions (as few overlaps as possible, ideally no board member as an executive officer), and always bring an independent board member. Building the right board committees and its process is also very important (budget, auditing, add-on acquisitions/M&A and compensation are normally the important ones).

Q.: What is your preferred exit strategy, and why? How are exit decisions made and what is the IRR?

Mr. Camoes: The preferred - and default exit strategy for the middle market continues to be trade sale. Having said that, we see secondary sales to other PE funds. A recent exit of the Alog datacenter illustrates that several PE firms made a bid for the asset, which eventually was sold to a joint bid from Riverwood (US based PE fund) and Equinix (a datacenter company listed in the NASDAQ). We also think that over time the local capital markets will play an increasingly important role in the intermediate liquidity or additional rounds of financing, as the Brazilian stock market is still concentrated in few very large companies.

Q.: How are private equity investors transforming the economies in Brazil and Latin America at large?

Mr. Camoes: In many ways, I'd select just two effects to illustrate, the first being the seminal effect on increasing the number of listed companies - depending how you measure, around 20-35% of IPOs in Brazil in the last years have been PE backed. Another element is the dissemination of good corporate governance practices, and the introduction of stock option programs in a number of companies, expanding the universe of companies with such instrument of alignment of interest between shareholders and executives (ESOP in Brazil are still today limited to very few companies or to subsidiaries of multinationals listed abroad).

Q.: Do you then foresee more IPO's by PE backed companies and are the listings primarily in Brazil or other exchanges? Also, how has the increase in IPO's transforming the Brazilian companies and economy?

Mr. Camoes: Listings are normally in Brazil, as we have a very active and booming capital markets - all types of PE firms do IPO's here - Brazilian sponsored firms, international, etc. The increase in IPO is transforming the Brazilian economy in a very positive manner - from more capitalized companies, to shareholders seeing its shares valued and with liquidity, to dissemination of good corporate governance practice, etc.